Goodbye Shale Producers

Jim Brown
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The U.S. shale revolution is over. Very few companies can still produce at a profit and the rest are heading into the abyss as production declines and cash burn accelerates.

Shale production was never very profitable even when oil prices were over $100. I have reported in these pages before that the top 50 shale producers spent $200 billion in E&P over the last five-years and incurred debt of $150 billion to do it. As long as they could keep drilling at a record pace and continue to increase production the cash flow machine continued to hum and investors were happy with small returns.

Now that the cash flow machine has developed more knocks, bangs and smoke than a 1953 Chevy, the investor class is running for the hills and for good reason. The shale producers are shifting from exploration mode into cash conservation mode. They know there is no additional lending capacity at their bankers. Their proved reserves are crashing because they are not economical at $40 oil. Production is declining because they cannot afford to drill new wells and cash on hand is shrinking.

Labyrinth Consulting pulled some numbers out of the SEC filings for some major shale producers. For the first half of 2015 Pioneer Resources (PXD), EOG Resources (EOG) and Continental Resources (CLR) all lost money on every barrel they produced. Without any debt infusions they cannot pull out of this slump. They are halting additional drilling and cutting costs to the bone in hopes of staying out of bankruptcy until prices rise.

Labyrinth claims Pioneer lost $23.48 on every barrel they produced. Continental lost $24.04 and EOG lost $9.74. The standing joke for a company losing money on every transaction is that "we make it up on volume." Unfortunately, that does not work for these companies. Their cash burn rate is rising despite a sharp cutback in drilling expenses.

Production from shale wells decline -65% in the first 90 days and 75% in the first year followed by another 25-35% decline in each of the next two years. Every well currently producing for these companies is in terminal decline. Some are just farther along the curve than others.

With companies slashing drilling expenses by not drilling anything they are not contractually obligated to drill, their high rates of initial production are dropping like a rock. They are trying to cut costs to less than cash flow in hopes of hanging on until prices recover. In the current market that could be late in 2016 according to the EIA.

Shale companies have debt payments, thousands of employees and billions in well servicing agreements. Their cash hoard is dwindling every day. Some will find it very difficult to survive for another 15 months until the end of 2016. So far, 11 companies have filed bankruptcy and several others have swapped equity for debt in order to avoid bankruptcy. Most of these are the small companies but it will not be long until the big fish begin to roll over and float to the surface as well.

In the coming Q3 earnings cycle the energy sector is expected to post a -65% decline in earnings. Guidance will be slashed and booked reserves will be cut. Lines of credit will be reduced based on the decline in cash flow and value of reserves. This will be an ugly cycle and equity prices should be a lot lower by the end of October.

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Active Rigs

Active drilling rigs declined -6 to 842 for the week ended on Friday and that is a 10 year low . Oil rigs fell -8 for the week to 644. Active gas rigs rose +2 to 198. Active rigs have now declined -1,089 since the high of 1,931 in September 2014. That is a -59.9% drop. Active offshore rigs were unchanged at 31, down -35 from year ago levels.

Oil Inventories

Crude inventories fell -2.1 million barrels to 455.9 million.

Refinery utilization rose unexpectedly from 90.9% to 93.1%. That is down from the high of 96.1% on August 7th.

U.S. production declined -18,000 barrels to 9.117 mbpd, down from the 9.61 mbpd and 40-year high in June. Demand rose +403,000 bpd.

Cushing inventories fell slightly to 54.5 million from 56.4 million.

Gasoline inventories rose +2.8 million barrels to 217.4 million. Gasoline demand fell -34,000 bpd.

Distillate inventories rose +3.1 million barrels to 154.0 million and a three-month high. Demand fell -83,000 bpd.

In the graphic below green represents a recent high and yellow a recent low.

Jim Brown

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